Despite the underperformance of fixed income we discuss in this Spotlight guide why the value proposition of the asset class hasn't gone away. In particular we review how the RLAM management team use existing, proven funds to actively manage consistent monthly income streams and adapt the portfolio to changing interest rate and credit market factors.

Within this guide, you will find some surprising survey results from FE, a selection of adviser opinions and some Architas views too. We hope this guide will provide you with some food for thought on this burning issue.

Missed opportunities

Neil MacGillivray outlines the value of by-pass trusts and explains why poor drafting of new legislation has resulted in lost opportunities

The Perpetuities and Accumulation Act 2009 (PAA 2009) was supposed to not only extend the period of time a trust under English law can exist but also clarify existing law. In relation to the use of by-pass trust arrangements put in place to receive pension lump sum death benefits, the new legislation would appear to fall well short of its objectives.

By way of background by-pass trusts are commonly used as a means of controlling who, how and when individuals receive any pension lump sum death benefits. For example, if a member of a pension scheme had children from a previous marriage, he may want to ensure that on his death his current wife is financially secure but, on her death, the remaining benefits pass to his children and not his current wife’s family or potential new partner. He could not guarantee that this would happen if the death benefits were paid directly to his second wife.

On the other hand if the benefits were paid to a trust, where the trustees control who benefits and when, he can ensure his wishes are carried out. The other major attraction of a by-pass trust is that the benefits held in the trust do not form part of the potential beneficiaries’ estates on their deaths. Based on the earlier example, the member’s second wife can get an income, capital payments and loans from the trust but the value of the benefits that remain held in trust do not form part of her estate. So, on her death, the trust assets are protected from inheritance tax (IHT) at a potential rate of 40%. The much lower ten-year anniversary & exit IHT charges are applicable to the trust.

The new legislation was supposed to give all by-pass trust arrangements set up from 6 April a perpetuity period of 125 years from the date the member joined the pension scheme. Unfortunately, due to bad drafting, the new rules are ambiguous and have been subject to as much debate as to interpretation.

Confusion

The ambiguity stems from which section of the Act is applicable. A literal interpretation of Section 15(1) (b) of the PAA2009 leads to the conclusion that where the scheme commenced before 6 April 2010, then the new rules would not apply because the power of appointment takes effect before 6 April 2010 irrespective of when the member joined the scheme and set up the by-pass trust. Fortunately, the alternative and most widely accepted view is that section 19 of the legislation actually applies. Under this section the power of appointment is treated as being created when the member joins the pension scheme.

It is therefore generally agreed that where a member joins a pension scheme on or after 6 April 2010 and then creates a by-pass trust, the by-pass trust will have a perpetuity period of 125 years from the date the member joined the pension scheme. However, for situations other than this it gets rather messy.

Where an individual joined a pension scheme prior to 6 April 2010 and now wants to enter into a by-pass trust arrangement they will, unfortunately, be reliant on the old rules. So where the member of the scheme creates a trust in his life time and through a letter of wishes nominates that the death benefits are paid to the trust (a pilot trust arrangement), then under the old rules, the most appropriate perpetuity period to apply would be 21 years after the member’s death. Therefore, if the member died at age 60 and his wife was 55 years of age at that time the trust would have to come to an end and the lump sum death benefits paid out when she was aged 76. This is far from ideal.

Getting around the problem

The solution to get round the problem of the shorter perpetuity period under the old legislation was, where suitable, to use a trust that carved out a right to the member’s death benefits (a carve out trust arrangement) rather than rely on a pilot trust arrangement. Under a carve out trust arrangement a full perpetuity period could be selected from the date the trust was created.

The reason why each of the two arrangements has different perpetuity periods is complicated. Under a pilot trust arrangement the scheme trustees must use their discretion to pay the death benefits into the trust. This is treated as the trustees exercising a power of appointment. In such circumstances, the benefits in the new trust inherit the perpetuity period of the pension trust. Pension trusts are however not subject to the perpetuity rules so it defaults to a maximum perpetuity period to that of the member’s life plus 21 years. For carve out trust arrangements the trustees of the pension scheme are obliged to pay the benefits to the by-pass trust. Benefits held in the by-pass trust are freed and discharged from the pension trust. This is the reason why the perpetuity period can run from the date when the by-pass trust was created. The aim of the new legislation was to simplify this.